Stumbling goes further: we need smaller banks not just because big ones will drag us all down if they fail, but because otherwise we have no chance of influencing their behaviour and making them invest in firms, not households. But government policy is just to fatten 'em up and flog 'em back to the market to carry on as before, or so he very plausibly speculates.
"In banking and most highly leveraged finance, size is a social bad. Fortunately, there is quite a list of effective instruments for cutting leveraged finance down to size.
- Legally and institutionally, unbundle narrow banking and investment banking (Glass Steagall-on-steroids).
- Legally and institutionally prevent all banks (narrow banks and investment banks) from engaging in activities that present manifest potential conflicts of interest. This means no more universal banks and similar financial supermarkets.
- Limit the size of all banks by making regulatory capital ratios an increasing function of bank size.
- Enforce competition policy aggressively in the banking sector, by breaking up banks if necessary.
- Require any remaining systemically important banks to produce a detailed annual bankruptcy contingency plan.
- Only permit limited liability for narrow banks/public utility banks.
- Create a highly efficient special resolution regime for all systemically important financial institutions. This SRR will permit an omnipotent Conservator/Administrator to financially restructure the failing institutions (by writing down the claims of the unsecured creditors or mandatorily converting them into equity), without interfering materially with new lending, investment and funding operations.
The Geithner plan for restructuring US regulation is silent on the too big to fail problem. That alone is sufficient to ensure that it will fail to result in a more stable and safer US banking and financial system.
In the UK, the otherwise enlightened head of the FSA, Adair Turner, does not see a problem with banks of huge size and with a staggering range of unrelated or conflicted activities. Of all the parties that matter, only the Governor of the Bank of England, Mervyn King, is clear that ‘too big to fail’ is at the heart of the financial crisis we are trying to exit and will be at the heart of the next financial crisis that we are preparing so assiduously."
So we have the outlines of three broad, overlapping but distinguishable, political economy worldviews:
1. The official position of both Tories and Labour: flog the banks back to the public sector once their balance sheets look a little less seasick, reduce the burden on public finances as soon as and as much as possible and twiddle the regulatory frameworks a bit at the edges. Those memories of the Great Moderation are so sweet that it seems impossible not to recreate that Arcadia, though perhaps we need a few more Black Swan management techniques.
2. The position of the 'guardian-priests' of the international financial system like Buiter, and, possibly, King: twiddling the regulations ain't going to work, though it is no doubt very necessary. We have to save the system from itself by radically redefining the power relationships between its component parts. We've had our Minsky Moment and we don't want another one. If that means governments - and tax payers - have to fore go some temporary relief, then so be it. We're playing for big stakes here and we can't afford to lose. Banks can't be so big as to potentially ruin us all. Interestingly, Vince Cable sometimes sounds like he's in this camp.
3. The position of the unbelievers: it's not just that our international banking - and shadow banking system - has proved so unstable, it's also how it operated before hand. Great inequalities were amplified and massive transfers channelled from poor to rich across the globe. Furthermore, in the heartlands, innovation and new enterprise was radically unattractive because it was so much less profitable to fund than consumption items, like housing, or simple speculation itself. We need to change this, perhaps for reasons of simple national competitiveness, perhaps for reasons to do with the need to green our economy or fry at some point before the end of the century. The banks should work for the rest of us, not the other way round.
What's interesting to me is that the debate around the wisdom or otherwise of stretching out or curtailing the current neo Keynesian demand stimulation policies - that whole 'Austerity v Growth' schtick - can be had within each of these perspectives*. So you get people who actually want very different things apparently agreeing with each other.
*2 hours later I discover Mervyn King has stepped forward to prove my point on this one. To Duncan's very great annoyance.